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East Coast Yacht's Expansion Plans

Larisa Warren, the owner of East Coast Yachts, has decided to expand her operations. She asked her newly hired financial analyst, Dan Ervin, to enlist an underwriter to help sell $30 million in new 20-year bonds to finance new construction. Dan has entered into discussions with Robin Perry, an underwriter from the firm of Crowe & Mallard, about which bond features East Coast Yachts should consider and also what coupon rate the issue will likely have. Although Dan is aware of bond features, he is uncertain as to the costs and benefits of some features, so he isn’t clear on how each feature would affect the coupon rate of the bond issue.

1. You are Robin’s assistant, and she has asked you to prepare a memo to Dan describing
the effect of each of the following bond features on the coupon rate of the bond. She
would also like you to list any advantages or disadvantages of each feature.

a. The security of the bond, that is, whether or not the bond has collateral.

b. The seniority of the bond.

c. The presence of a sinking fund.

d. A call provision with specified call dates and call prices.

e. A deferred call accompanying the above call provision.

f. A make-whole call provision.

g. Any positive covenants. Also, discuss several possible positive covenants East Coast
Yachts might consider.

h. Any negative covenants. Also discuss several possible negative covenants East Coast
Yachts might consider.

i. A conversion feature (note that East Coast Yachts is not a publicly traded company).

j. A floating rate coupon.

Dan is also considering whether to issue coupon bearing bonds or zero coupon bonds. The YTM on either bond issue will be 8 percent. The coupon bond would have an 8 percent coupon rate. The company’s tax rate is 35 percent.

2. How many of the coupon bonds must East Coast Yachts issue to raise the $30 million?
How many of the zeroes must it issue?

3. In 20 years, what will be...